Department of Labor Releases Much-Anticipated Fiduciary Rule
April 16, 2015
After many delays and prolonged anticipation, the Department of Labor (DOL) finally released hotly contested, proposed a new fiduciary rule, which would increase the number of plan service providers falling within the definition of “fiduciary.”
If the new fiduciary rule is adopted, financial advisors will be subjected to significantly higher legal standards governing their retirement plan investment advice practices.
The DOL’s new fiduciary rule has been in the works for more than five years. The DOL abandoned its last proposal, which was released in 2010, after it received widespread criticism and pushback from the financial services industry.
The latest proposal would expand the number of financial professionals who are subject to the fiduciary “best interest standard,” which requires such advisers to put the client’s interests before their own. Those affected would include brokers, registered investment advisers (“RIAs”), insurance agents, administrative service providers and salespeople.
The following individuals, however, would be excluded from fiduciary status:
(1) brokers acting strictly as order-takers for customers instructing the broker exactly what to buy or sell without asking for advice;
(2) financial institutions (intending to act as counterparties) making a “sales pitch” to fiduciaries of large plans with financial expertise;
(3) providers of non-fiduciary “investment education” only to IRA clients who do not identify specific investment products; and
(4) providers of valuations for ESOP stock.
Under the proposed rule’s expanded definition of who is a fiduciary under the Employee Retirement Income Security Act (ERISA), an advisor is a fiduciary if that person receives compensation for providing advice that is individualized or specifically directed to a particular plan sponsor, plan participant, or IRA owner for consideration in making a retirement investment decision. Such decisions can include, but are not limited to, what assets to purchase or sell and whether to rollover from an employer-based plan to an IRA. They expressly do not include general retirement advice, order-taking, and sales pitches to plan fiduciaries with financial expertise.
Under the new fiduciary standards, financial advisors to plan sponsors, plan participants, and IRA owners are not permitted to receive payments that create conflicts of interest without a prohibited transaction exemption (PTE). The DOL’s new fiduciary rule creates a new type of PTE known as the “best interest contract exemption.”
As described by the DOL, the new PTE “allows firms to continue to set their own compensation practices so long as they, among other things, commit to putting their client’s best interest first and disclose any conflicts that may prevent them from doing so.” Common forms of compensation, such as commissions, revenue sharing and 12b-1 fees, would be allowed, whether paid by the client or a third party such as a mutual fund.
To qualify for the exemption, however, the fiduciary advisor must enter into a written contract with the client that provides for the following:
(1) committing to the “best interest” fiduciary standard;
(2) representing and warranting that the fiduciary advisor has adopted compliance policies designed to mitigate conflicts (and that there is no differential compensation or any other incentives encouraging individual advisors to make improper recommendations);
(3) certifying that conflicts have been identified and disclosed (and providing a web address to review additional compensation disclosures); and
(4) granting a private right of action against the firm for contractual breaches (referral of any dispute to arbitration is permitted provided there is no bar to bringing class action lawsuits).
The failure to adopt “appropriate compliance policies” would not necessarily result in a violation of this exemption, but would expose the non-compliant advisor to a private right of action by the customer for contractual breach.
“Advisers can have considerable flexibility in how they get paid as long as they put their clients’ best interest above their self interest,” DOL Secretary Thomas Perez stated. “The rule is intended to provide guardrails but not straightjackets.”
In addition to the Notice of Proposed Rulemaking, the DOL published several related documents, including a fact-sheet on the proposal, on the agency’s website. Once the rule is officially published in the Federal Register, the public will have 75 days to comment. Given the amount of feedback the DOL is likely to receive, the rule may be subject to further revisions before it becomes final.
The other wild card in this process involves possible actions taken by the Securities and Exchange Commission (SEC), which is currently considering its own fiduciary rule and which could bring broker-dealers and registered advisers under the same ethical standards. Because many financial firms are subject to oversight by both sets of regulators, the financial services industry had hoped that the DOL would wait for the SEC to act. As many critics have warned, the prospect of two sets of rules could produce a compliance nightmare.